Comments on economics, mystery fiction, drama, and art.

Tuesday, October 19, 2004

On Robert Lucas on Ed Prescott

Ed Prescott recently was the co-recipient of the Bank of Sweden Noble Memorial Prize in Economics. Some time ago, Robert Lucas had this to say about his work with Prescott, on search theory in labor markets:

“Ed had provided an equation that claimed to explain how labor markets work. It was my job to understand it and decide whether I agreed with this claim. This took me a while, but I saw that Ed had replaced an assumption of mine that workers who leave any one location hit on a new location at random -- maybe a worse location than the one they had left -- with the alternative assumption that searching workers were fully informed about options elsewhere and bee-lined for the best destination.”

(From David Warsh, “A Day in the Life of Ed Prescott,”

Unquestionably the approach Prescott suggested and that he and Lucas developed was interesting and exciting and provided many issues to develop. (One of the implications, of course, is that all unemployment is voluntary. If workers are fully informed and can “bee-line” elsewhere, then any unemployment is the consequence of choices made by workers NOT to do that.) It’s just too bad that Lucas’s initial assumption—random job search—and Prescott’s replacement of that assumption—perfectly informed job search—are both divorced from reality. Much more difficult than either of these, but also a much closer fit to what workers actually know, is imperfect knowledge of where to search, search that’s neither random nor fully informed. Of course, this is much harder to model.


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